Oz Housing Recovery Starting To Happen

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-Strong earnings seen for developers
-Approvals improve but mainly units
-Materials production, prices on the up
 

By Eva Brocklehurst

Signs of an upturn in Australian residential building have been welcomed. Analysts are still cautious as the trend remains modest and there is some distance to go before the recovery is considered well in train. Residential building was the best performing real estate asset class in the first part of 2013, as interest rate reductions made an impact and drove investor demand. The housing rebound is also underpinned by signs of a turnaround in materials consumption and production, a key early indicator.

JP Morgan believes the recovery is still in the early stages but there should be strong earnings growth coming along for residential developers, even before any material operating improvements. The broker remains Overweight on Stockland ((SGP)), Mirvac ((MGR)) and Lend Lease ((LLC)). Australand ((ALZ)) was recently upgraded to Overweight as well. House prices are on the up and up in Sydney, Perth and Melbourne. South east Queensland is stable but recovering from depressed levels. Sydney is underpinned by strong demand and JP Morgan expects it will be the best market in FY14, showing good volume and price growth. Perth is expected to peak in terms of volume growth but sustain good price growth. A material improvement in investor sentiment towards residential and foreign (Chinese) buying should also induce further price growth, as developers and lenders are likely to respond relatively slowly.

Residential A-REIT volumes should continue to improve over the next year and the broker allows for a cumulative two-year market price accretion of 20% in Sydney, 15% in Perth and 10% in Melbourne and south east Queensland. Margin recovery is being assisted by improving volumes and prices. Pre-sales of properties provide this view of improved investment returns and margins but JP Morgan is still not allowing for material improvements in operating conditions in forecasts. Instead, assumptions are made for some volume growth, inflation-covering price improvement and modest margin expansion. This translates to the A-REIT developers achieving 11% returns on investment capital in FY15. This is the broker's base case and could turn out to be conservative.

Citi thinks stage is set for recovery in residential construction but, keeping a similar line to JP Morgan, suspects it is still subdued. Building approval levels are considered okay but, in order to reach historical averages, stronger growth is needed in the areas of new home sales and detached housing. The broker believes that because of the current weakness in resource related projects, residential construction is critical for the economy. Confidence in residential building needs to be supported by government reforms to ensure sustainable growth. Citi maintains that lower interest rates will support a recovery but, to achieve healthy activity, policies around credit and taxes may have to be tweaked towards improving the housing supply.

Building approvals regained momentum in July and were up strongly, revealing a firm start to the new financial year. Residential construction vis-a-vis GDP is showing signs of stability and Citi maintains this shows RBA official rate cuts over the last two years have supported recovery. Although, the cash rate was left unchanged in September, Citi expects it will be cut again in the December quarter, to maintain the momentum of growth in residential building. Overall, the strength in approvals recent months has been largely in the multi-unit area. Approvals for houses were still up 10.6% year on year in July but are showing a slower rate of recovery. Actual housing starts in the March quarter were up 12.6% year on year and Citi expects June quarter commencements will be up around 7%. Further down the chain the residential work done in the June quarter, up 5%, was largely led by new units, as houses and alterations and additions were flat.

One other area suggestive of demand is housing affordability.The median house price to household income was down at 5.3 times in the June quarter and the House Price Index grew 5%. Housing affordability has benefited from income growth and lower interest rates but this has been partially offset by increases in house prices.

Citi has improved the recommendation on building fixtures company GWA Group ((GWA)) to Neutral from Sell to reflect the likelihood that the housing cycle has bottomed, expecting FY14 earnings should improve. Residential developer Peet ((PPC)) is also a candidate for a recommendation upgrade to Buy from Neutral because it is an early cycle beneficiary from residential housing improvement. While interest rates at 2.50% are expansionary, Citi is still concerned about the sustainability of the recent activity, as deposit taking on residences still needs to translate into contracts.

In more detail on the buidling materials front, concrete data from the Australian Bureau of Statistics indicates production was on the increase in August. Goldman Sachs notes NSW consumption of concrete was up 3.1% in the month although Victoria was down 8.8%. For 2013 to date, concrete consumption is up 1.5%. Citi also observes materials production is improving. Cement production volumes were up 14% year on year in the June quarter, the highest growth since June quarter 2005. Concrete was up 3% and brick production up 16% year on year. This is the first positive growth in brick production since the June quarter 2011. In terms of product pricing brick prices were up 6.6% while asphalt prices grew 1.0% y/y and concrete, cement and sand prices grew 0.5% year on year Insulation prices were up 1.2%.

A risk to this nascent recovery is higher unemployment, although JP Morgan thinks a modest shift up in unemployment levels won't necessarily push house prices down. The Reserve Banks has noted that mortgage buffers remain near their highs, equivalent to around 21 months of total scheduled repayments at current interest rates. The data suggests to the central bank that many households have the resources to continue to meet debt obligations even during a transition period of unemployment or reduced income. What seems more apparent is the upside risks. From a price positive perspective there is evidence emerging that attitudes towards property investment have markedly improved. The broker points to a graph below highlighted by the Reserve Bank recently that shows the number of people thinking property is a wise investment is back to early 2000 levels. We all know what happened to prices back then.
 

 

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